How Are Contract Employees Defined, Should They Be Included in Workers’ Comp Payroll?

workers' compensation

While employers must purchase Workers’ Compensation insurance to cover employees for on-the-job injuries and illnesses, determining whether it’s necessary to provide coverage for independent contractors, also known as 1099 contractors, can be confusing. Because independent contractors are not necessarily “direct employees” of a company, a business owner may believe these workers are not eligible for Workers’ Comp coverage. It’s not so cut and dried, however.

There are three factors employers should clarify if they use 1099 workers in their business. Employers should understand exactly what an independent contractor is. They should also be aware of the specific criteria that defines who is and is not considered an employee according to their state Workers’ Comp laws. Lastly, employers need to ensure they don’t misclassify employees and include all those eligible for coverage in their Workers’ Comp payroll. 

Who Is an Independent Contractor?

An employer must determine who in the working relationship is calling the shots. Generally speaking, if the employer is responsible for directing the contract employee, he or she is considered an employee and should be classified as such as under the business’s Workers’ Comp policy. Following are several questions that can serve as a guideline to determine whether an employee is under the direction and control of an employer:

  • Does the individual take instruction from the company’s management staff with regard to when, where, and what work is to be done? Or does the contractor control the means, manner, and method of getting the job completed? 
  • Does the employer provide the individual with training? Most independent contractors use their own methods and receive no training.
  • Does the employer provide the individual with supplies, tools, or materials to perform the work?
  • Is there a continuing relationship between the employer and the individual? How does the contract employee view the nature of the relationship?
  • Must the individual work set hours?
  • How is the individual paid – by the hour, week, or month?
  • Is the individual reimbursed for business/travel expenses?
  • Can the person work for others?
  • Can the person be hired or fired? (Can the worker be dismissed for reasons other than non-performance of contract specifications?) The right to discharge an individual is clearly an “act of control” and reflective of an employer/employee relationship.
  • May the individual terminate his/her services at any time? 

The idea behind these and other questions is to determine if the business owner has fundamental control over the daily activities of the worker. Note that even if workers are granted considerable discretion in determining how they do their work, as long as the employer retains the legal right to control their activities, the workers are considered employees.

For example, let’s say a day care requires some HVAC work done at its facility and hires a contractor to do the work. The contractor sets his own hours, uses his own tools, and gets paid for this specific job. He is truly an independent contractor and should have his own Workers’ Compensation insurance, which he can demonstrate with a Certificate of Insurance (COI). On the other hand, let’s say this same day care hires an individual to help out with child supervision while someone is out sick. The day care owner is providing direction, assigning tasks, setting the work schedule, etc. Although the business is paying the individual as a 1099 worker, in this case there is an employer-employee relationship and Workers’ Comp should be provided. 

The Workers’ Comp Payroll Audit Tells the Story

After the policy term, an insurance company will perform a payroll (or premium) audit to determine if the estimated payroll amounts at the beginning of the policy period are in sync with the actual payroll amounts that occurred during the policy period. As part of the audit, insurers will look at how each employee has been classified and verify if these class codes are correct. They will also review the business’s use of subcontractors and independent contractors. For each of these contractors, an employer should provide documentation (COI) illustrating that their 1099 workers carry their own Workers’ Compensation insurance. If a COI is not provided, it typically results in further investigation to determine whether the independent contractor should have been included in the payroll for Workers’ Compensation coverage. The auditor will ask the business owners detailed questions about their work processes and dig deeper into the individual duties of the independent contractors with the purpose of identifying their proper classification. If the business owners are unable to justify the classification assigned to the independent contractor, the insurer will pick up the Workers’ Compensation exposure during the audit and charge for it. 

It’s important for business owners to properly classify their workers to avoid potential red flags during the payroll audit process. It’s also critical to understand specific state laws regarding Workers’ Compensation in which a business operates.

About Prescient National

Prescient National offers Workers’ Compensations solutions to employers based on their individual needs, risk-taking appetite, and loss history: guaranteed cost policies, small-, mid-size, and large-deductible policies, retrospective rating policies, excess/self-insurance, and captive options. 

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